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BOTTOM LINE: Overall, last week's market performance was bearish. The advance/decline line fell, most sectors declined and volume was about average on the week. Measures of investor anxiety were mostly higher. The AAII % Bulls fell to 36.50% and is still below average levels. The % Bears fell to 42.62% and is still above average levels. Moreover, the 10-week moving average of % Bears is 42.4%, the highest since the bear market bottom in October 2002. Many other measures of investor sentiment are still near levels associated with meaningful market bottoms.
The average 30-year mortgage rate fell to 6.74%, which is 153 basis points above all-time lows set in June 2003. I still believe housing is in the process of slowing to more healthy sustainable levels. Mortgage rates have likely peaked for the year and will trend lower over the intermediate-term.
The benchmark 10-year T-note yield fell 7 basis points on the week as economic data were mixed, import prices decelerated and violence in the Middle East spurred safe haven buying. I still believe inflation concerns have peaked for the year as investors continue to anticipate slower economic growth, unit labor costs remain subdued and the mania for commodities continues to reverse course.
The EIA reported this week that gasoline supplies fell more than expectations as refinery utilization declined. Unleaded Gasoline futures rose, but are still 20.2% below September 2005 highs even as refinery utilization remains below normal as a result of the hurricanes last year, some Gulf of Mexico oil production remains shut-in and fears over future production disruptions persist. According to TradeSports.com, the percent chance of a US and/or Israeli strike on Iran this year has fallen to 16.5% from 36% late last year. I continue to believe the elevated level of gas prices related to shortage speculation and crude oil production disruption speculation will further dampen fuel demand over the coming months, sending gas prices back to reasonable levels.
Natural gas inventories rose more than expectations this week. Supplies are now 27.4% above the 5-year average, an all-time record high for this time of year, even as some daily Gulf of Mexico production remains shut-in. Natural gas prices have plunged 60.0% since December 2005 highs. There is still little evidence of a pick-up in industrial demand for the commodity despite the collapse in price. Natural gas has likely made an intermediate-term bottom before moving to new cycle lows in November or December.
US oil inventories are still around 8-year highs. Since December 2003, global oil demand is down 1.19%, while global supplies have increased 5.19%. Currently, global supplies of oil are exceeding demand by 2.1 million barrels per day. Moreover, worldwide inventories are poised to begin increasing at an accelerated rate over the next year. I continue to believe oil is priced at extremely elevated levels on fear and record speculation by investment funds, not fundamentals. Escalating violence in the Middle East and the onslaught of hurricane season will likely lead to a major top in oil over the next few months as demand destruction accelerates further. As the fear premium in oil dissipates back to more reasonable levels, global growth slows and supplies continue to rise, crude oil should head meaningfully lower over the intermediate-term.
Gold and the US Dollar rose for the week on safe haven buying as a result of rising geopolitical concerns.
Technology and cyclical stocks underperformed for the week on disappointing earnings forecasts and fears over a decline in consumer spending. Despite a 69.2% total return for the S&P 500 since the October 2002 bottom, its forward p/e has contracted relentlessly and now stands at a very reasonable 14.4. The average US stock, as measured by the Value Line Geometric Index(VGY), is down 2.7% this year. The Russell 2000 Index is still up 1.8% year-to-date, notwithstanding the recent correction. In my opinion, the current pullback is still providing longer-term investors very attractive opportunities in many stocks that have been punished indiscriminately.
In my entire investment career, I have never seen the best “growth” companies in the world priced as cheaply as they are now relative to the broad market. By contrast, “value” stocks are quite expensive in many cases. Moreover, the most overvalued economically sensitive and emerging market stocks should continue to underperform over the intermediate-term as the manias for those shares subside. I continue to believe a chain reaction of events has begun that will eventually result in a substantial increase in demand for US stocks.
In my opinion, the market is still factoring in way too much bad news at current levels. Problematic inflation, substantially higher long-term rates, a significant US dollar decline, a “hard-landing” in housing, a plunge in consumer spending and ever higher oil prices appear to be mostly factored into stock prices at this point. I view any one of these as unlikely and the occurrence of all as highly unlikely.
Over the coming months, an end to the Fed rate hikes, lower commodity prices, decelerating inflation readings, lower long-term rates, increased consumer confidence, rising demand for US stocks and the realization that economic growth is only slowing should provide the catalysts for another substantial push higher in the major averages through year-end as p/e multiples begin to expand. I still believe the S&P 500 will return a total of around 15% for the year. The ECRI Weekly Leading Index rose again this week and is forecasting healthy, but decelerating, US economic activity.
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